California City Continues Bid to Seize Underwater Mortgages

Banks and city officials in Richmond, Calif., continue battling over a local plan to use eminent domain to seize and refinance underwater mortgages. City officials want to use eminent domain to obtain 624 mortgages which the city (population 103,000) has deemed as in danger of foreclosure, which they argue would result in a slide in property values and neighborhood stability.

Richmond City Council voted 4-3 on Tuesday to move forward with the plan, according to accounts in the local media, but conceded to state law which requires a super majority to support each eminent domain move.

Thus, the Richmond plan remains in limbo. Other communities in California and Nevada have raised the possibility in the past of using eminent domain in this way, but backed off in the face of strong opposition from mortgage originators and Realtors. NAFCU and other trade groups also have spoken out against the idea.

Also, if it does decide to invoke eminent domain, the city almost certainly faces another legal challenge. A U.S. District Court judge threw out the banks' first legal challenge last week, ruling that they' have no standing to bring a case until and unless Richmond actually invokes eminent domain and moves to take a loan. Once the city does so, observers expect the banks to revive their complaint.

If eminent domain is obtained, Richmond would work with a private firm, Mortgage Resolution Partners, and the homeowners to restructure and refinance the loans at more-current market values and then sell them to other investors that San Francisco-based MRP would help find.

Opponents of the plan, dubbed the Richmond Community Action to Restore Equity and Stability, charge that the Bay Area city and MRP stand to make money on what will amount to little more than unconstitutional taking of private property for an unclear public use.

In arguments filed in court as part of an effort to prevent the plan from going forward, banks and investment firms which own the mortgages contended, among other things, that the city has targeted the mortgages which are performing and whose homeowners are not in immediate risk of going into default.

They also maintain that they stand willing to help homeowners in default modify their loans if they do go into default and that they have done so already on other loans in Richmond and, finally, that home values in Richmond rose by 20% last year and are expected to by another 20% this year. That may restore some home values to more than their loan values again, the banks and investment firms argue.

In addition, the Federal Housing Finance Agency, regulator and overseer of secondary market giants Fannie Mae and Freddie Mac have also weighed in against the idea.

But supporters of the plan vigorously contend that the move would help preserve long-term value for the entire community by limiting foreclosures and preserving the neighborhoods as places residents want to live.

“Consider two neighborhoods plagued by underwater loans,” wrote John Vlahoplus founder and chief strategy officer at MRP in an email. “In the east neighborhood, defunct institutions own the loans; the city buys the loans, reduces principal, prevents defaults/vacancies/crime/foreclosures etc., and improves the public good.

“In the west neighborhood, ongoing institutions hold the loans and refuse to sell them, with the result that the neighborhood suffers defaults/vacancies/crime/foreclosures etc. It does not make any policy sense for the government to let the west go down this way. Worse, imagine that the two neighborhoods are adjacent, so that the crime and blight from the west spill over into the east and undo the good that the government had created by stabilizing that neighborhood. Again, it makes no policy sense to let the west go down and take the east with it.

“The only difference is that the government must take into account potentially competing interests when it considers condemning loans from ongoing institutions that refuse to sell the loans. But that is government's role and its right under our constitutional system of government.”

The mortgages at stake were made on real estate in working class and lower working class neighborhoods that were made during the height of the run-up to the housing finance crisis. Since the mortgages were not sold to Fannie Mae or Freddie Mac but went instead into so-called private label mortgage-backed securities, the loans have not been available to refinance under the federal government's HARP 2 program.